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UK about to enter turbulent seas

06 May 2015 - 08:27
Anatole Kaletsky

Labour leader Ed Miliband delivers a speech to supporters at a Citizens UK election assembly in London on Monday. There is a slightly more than 50% likelihood of a Labour-led government emerging from tomorrow’s uncertain British election. Picture: REUTERS

WHICH European country faces the greatest risk of political instability and financial turmoil in the year ahead? With the UK’s general election just a day away, the answer is both obvious and surprising. Once a haven of stability amid the turmoil of the euro crisis, the UK is about to become the most politically unpredictable member of the European Union (EU).

Indeed, continuity is the one election outcome that can almost certainly be excluded. Unless opinion polls are unusually inaccurate, the two parties comprising the government coalition, Prime Minister David Cameron’s Conservatives and the Liberal Democrats, have almost no chance of winning a combined parliamentary majority.

One possibility — with a probability slightly above 50% according to the polls — is that the UK will soon have a Labour-led government committed to the biggest tax-raising programme since the 1970s. Moreover, because of the peculiarities of the UK’s electoral system and the rise of Scottish and Welsh nationalism, a Labour government’s survival would depend on the support of parties with even more radical economic agendas and dedicated to dismantling the UK.

Another scenario is a weak and unstable Conservative government. To judge by the opinion polls, Cameron’s best hope is to win more parliamentary seats than Labour and try to form a minority government, which could survive as long as the other parties failed to unite against it.

But Cameron would be vulnerable to blackmail by his own party’s dissidents and extremists, who see it as their historic mission to pull the UK out of the EU.

Although the electoral arithmetic makes a stable centrist government almost impossible to imagine, continuity is the outcome that most international business leaders and politicians seem to expect.

The clearest evidence of this can be seen in financial markets. Although the pound has declined by about 10% from its peak of $1.70 last September, sterling weakness has simply reflected the dollar’s strength. In the same period, sterling has risen almost 10% against the euro, while British share prices have hit record highs and government bonds have generated better returns in the UK than in the US, Germany or Japan.

What accounts for this apparent indifference to the looming political risks? Many international observers believe politics simply no longer matters much in the UK because the economy is sound and growing at a fairly healthy pace. But this is a dangerously complacent argument.

Yes, the UK recorded the fastest economic growth among the major Organisation for Economic Co-operation and Development countries last year and has an unemployment rate of only half the EU average.

But these favourable indicators obscure a source of enormous risk: one of the world’s largest external deficits, financed last year by foreign-capital inflows totalling $160bn.

As long as the UK was a haven of political stability and tax policies favourable to foreign investors, it had no problem attracting capital inflows.

But the impending shifts in UK politics and its EU relations are bound to draw attention to the dependence on foreign finance.

A Labour government, wielding tax proposals specifically designed to hit private foreign investors, would certainly discourage inflows. But international investors might be equally put off by a weak Conservative government dominated by the party’s Europhobe wing.

The election marks the beginning, not the end, of a period of uncertainty for UK politics, economics and finance. No amount of lingering faith in stability will change that.